Download How to use basic economic principles in your daily and financial life

How to use basic economic principles
in your daily and financial life as
Engineer
A quick and simple definition of economics is the
study of choices and behaviors. Economics focuses
on why we make the choices we do. And what the
implications of those choices are.
Broadly speaking, economics is the study of how
society produces goods and services to meet the
needs and wants of a population. The many
different aspects of economic science includes
labor economics, monetary theory and supply-side
economics, to name just a few. The principles of
economics determine if we can buy a new
computer, whether our employer will be hiring or
laying off workers and government taxation. In
short, economics studies the world in which we
live.
Supply and demand
Of all the concepts within economics, supply and
demand is perhaps the most well-known by the
general public. It's notion is rather simple: In the
marketpace, buyers and sellers go back and forth
on price until an agreement is reached. In
economics, we call the point of agreement
equilibrium. In other words, the buyer's price and
the seller's price are now "equal."
How does this relate to you? Well if you've ever
heard or bought or sold something on Ebay, then
you've seen this in action! People bid on items for
sale for a given length of time. When time expires,
the one who bids the most get it.
Supply and demand theory says that as more
people demand something, the more they'll end-up
paying for it. With Ebay, the more people
bidding("demanding") on something, the higher the
winning bid will be.
But what about new sellers coming in during the
auction period with the same or a similar item for
sale? How would this impact things? What effect
would this have on the winning bid? And how will
it effect the other sellers? Well supply and demand
theory talk about this exact situation!
In economics, the end result depends on a couple of
things. Chief among them is whether the other
sellers are offering an item that's just as good, even
better, or of lesser quality.
Think about it. Would you pay more for something
that's not as good as something else? No way!
You'd pay less to compensate for the lower quality.
And that's exactly supply and demand theory says
would happen. And so, sellers of damanged, older
(outdated), or not working items should expect a
lower price.
In other words, economic theory says that if a
working item that's in pretty good shape is selling
right now for $50, then another item that's similar
to it but is damanged should sell for less. Take a
look at the bidding on Ebay and you'll see this
exact situation happening!
So basic ecnomic theory can help predict the
outcome. Or at least, give you a better sense of
what might happen over time. As a buyer, you can
use this principle to help avoid overpaying for
something. And as a seller, you can pick up on
something that makes your item more attractive
and a better buy.
Opportunity cost
A basic principle in economics is the concept of
opportunity cost. Simply put, it's the notion that
there are trade-offs involved when making
decisions.
For example, you have $1000 to spend. Should you
invest it all in the stock market? Buy a big screen
TV? Use it to pay down debt? Or leave it in the
bank?
Economic theory would evaluate the pros and cons
of going with any of these decisions. In other
words, it would show you what you'd be giving up
and gaining with each.
For example, the difference between putting the
money in the bank and buying a big screen
television is that putting it in the bank would earn
you some interest. So going with the TV means
giving up bank interest.
The opportunity cost here would be the lost bank
interest you could have gotten if you put the money
in the bank instead of buying the television.
Knowing this, is the purchase of that TV a good
idea? Well that's a personal choice, but economics
can help you realize what you might be giving up.
This same principle can be used when deciding
whether to start a business, leave a job, or accept a
promotion or pay cut. Ask yourself: What would I
be giving up if I made this choice? The answer =
your opportunity cost(s).
If you feel that what you'd be giving up is too risky
or too much, then perhaps it's not such a good idea.
Microeconomics and Engineers
As the name implies, microeconomics studies the
economic choices that individuals, households
and businesses make based on supply and
demand. The core concept of microeconomics is
the law of supply and demand, or as economist
Adam Smith termed it, "the invisible hand" in
his seminal book, "An Inquiry into the Nature
and Causes of the Wealth of Nations." An 18th
Century capitalist, Smith was referring to how
competitive markets efficiently determine how
goods and services will be allocated among the
population. The law of supply and demand
states that demand for a good is a function of its
cost to the individual while supply is a function
of its profit to the supplier.
Generally, as the price of a good increases, the
demand for that good decreases. Conversely, as
price increases, producers will make more,
increasing the supply. In an efficient market,
buyers and sellers, guided by Smith's "invisible
hand," will settle on the number of goods to
produce and how much to pay for those goods.
Although they form the basis of microeconomic
study, supply and demand are not the only
determinants of how a society allocates
resources. For example, as a producer
manufactures a good, the marginal cost -- or the
cost of producing "the next one" -- changes. At
first this marginal cost decreases the more goods
are produced, but eventually the cost levels off
and begins to increase. In other words, the cost
of producing another item costs the
manufacturer too much. On the demand side,
consumers must make choices about what to
buy with their limited money. Simply because
the market is offering a lot of apples at a good
price does not mean we will buy more apples
than what we want. The marginal utility of the
last apple has decreased to a point where we
prefer to use our money elsewhere.
Within economics, there are two concentrations.
One is called microeconomics and focuses on the
"small
picture."
The
other
is
called
macroeconomics and focuses on the "larger or big
picture."
Microeconomics looks at the behaviors of
individuals, which we call consumers or
households in economics. How can you use this in
your own life? Well take a good look at your own
company or neighborhood. For example, is your
company doing well? Or how are home prices
and/or foreclosures in your local area?
If you were to learn that there was a foreclosure in
your area, is that a sign of more to come? Is it just
one particular person who got him or herself into
trouble? If it because that house and/or property
wasn't well-kept and maintained?
Microeconomic theory looks at these issues to help
you decide whether you should be worried. And if
so, what are your choices and how might you be
effected. It does this by gathering research and
statistics that you then use to make informed
decisions.
In your own life, you can pretty easily gather this
information yourself by simply watching or reading
the news. Or talking to others--friends, family, coworkers, bosses, etc.
Look for trends! And if you get a sense that things
are rough or going to get tougher, then begin
planning for it. Also look to see if those trends
seem to indicate a short or a more long-term
problem.
In other words, if it only looks like it'll be bad for a
short while, then there's no reason to panic and
overreact. But if it appears that it'll get worse and
last for a while, then you should begin planning for
the worst.
Lastly, take a look at microeconomic trends in
other places outside your own! Why? Because as
we often see in economics, as something effects
one thing, it can also impact something else.
Sometimes this occurs right away; other times, it
happens later on.
Perfect example: A strike at a local plant. You may
think this only effects those people who work for
that company and live in that area. But not so! It
can also effect that plant's customers, suppliers
(vendors),
other
businesses,
and
other
communities.
As one union goes on strike, it's not uncommon for
other unions to join in as a show of unity. Or one
local union may strike, yet that same union in a
different community might decide to participate or
strike too in a show of unity. Local businesses
might suffer as striking workers and their families
cut back on expenses.
Macroeconomics and Engineers
Macroeconomics is the study of large-scale
economic inputs such as employment, inflation,
growth rate, disposable income, etc. Where
microeconomics is based on the law of supply and
demand, macroeconomics concerns itself with the
competing goals of consumers, businesses and
governments and the effect those goals have on
prices, employment and output.
The study of macroeconomics began in earnest
during the Great Depression of the 1930s, when an
Englishman named John Maynard Keynes
proffered a theory of how monetary and fiscal
policy could be used to manipulate the
unemployment rate. By monetary policy, Keynes
was referring to how a government controls the
cost of money in circulation. In the United States,
this falls to the Federal Reserve, which attempts to
control inflation by setting certain interest rates.
Fiscal policy refers to the spending decisions made
by the executive and legislative branches.
In "The General Theory of Employment, Interest,
and Money," Keynes advocated the use of
government spending to "prime the pump," or to
inject money into the economy to spur spending.
He argued that a short-term deficit -- spending
more than one takes in -- is acceptable to reduce
the negative effects of a recession. Over time,
competing theories have replaced Keynes's, but the
idea that monetary and fiscal policies can be used
to help control the economy remain central to
macroeconomics
As I mentioned above, macroeconomics
concentrates on the big picture. So instead of
looking at individuals, it looks at all of them
combined--groups!
So that strike at a local plant--a microeconomic
event--becomes a macroeconomic event because it
effects the overall economy. In other words, the
local strike hurts mainly the local area (economy).
But it also impacts the overall economy (whole city
or state, or the entire country).
How? Well for one thing, tax revenue may decline
as striking workers cut back on their spending. This
causes the amount of city and/or state sales tax to
be less. And as a result, the city and/or state may
have to cut back on providing services. Or be less
able to repay their debts. Remember, tax revenue is
government's main source of revenue!
It could also ripple to other states and countries if
the suppliers to local businesses are outside there.
For example, that plant buys its cleaning products
from a supplier in a different state. Due to the
strike, the plant may cut back on orders. So now a
company in a state where they're not striking is
being impacted. As a result of this, that company
might have to cut back on its own expenses or look
for another customer to make up for it. So the sales
rep handling the plant's account could now be
losing out on commission. As a result, he or she
may have to work harder to supplement that loss or
cut back on his or her own spending.
All this means that you should look at the larger
picture too! Look for any signs of something
happening elsewhere that might effect you. If
another office of your company is cutting jobs or
reducing costs, then maybe your office will do the
same at some point. So look for possible trends and
potential implications!
Watch interest rates
The most important rates to watch are the Federal
(Fed) Funds and Prime rates. Why? Because
lending rates on many things are based on these! So
if these go up, then your rate will probably go up
too. And if they go down, then yours might too.
Home mortgage rates are tied to the prime rate. In
other words, lenders take whatever the prime rate is
and then tack on extra. How much extra? Well that
varies from lender to lender, but it's often 2-5%
over and above the prime rate.
Credit card rates are also based on these. The
difference is that they often tack on even more than
home mortgages! And that's because you don't
have anything of value the lender can take if you
default (cannot repay).
Auto and boat loans are also based on the prime
rate. And like home mortgages, lenders add extra
on top of it. So watching what interest rates are
doing or where you think they may be heading can
be of great assistance!
For example, if you believe interest rates will be
coming down, then perhaps you will want to hold
off on refinancing or taking out a loan. Why?
Because if you're right, then you can borrow at a
lower rate and save on interest.
The big problem, as economic theory does point
out, is the degree of uncertainty. And that's why
economics is not an exact science! It looks at
possibilities and trends. This is exactly what you
must do--look for trends and gauge risks.
In other words, don't rely upon 1 source for your
info! Get info from a variety of sources to see
where there's agreement and what's different. And
look for any biases that may be skewing that info!